Pension bonds are an ingenious idea for providing retirement income

WHEN people stop working, they need a retirement income. Some are lucky enough to have an employer-provided pension linked to their salary. Everyone else faces a difficult choice.

Some keep their pension pot in cash and watch as it is eroded by inflation. Others use savings products with high fees and risk being hurt by a stockmarket downturn. A third option is an annuity, which guarantees a lifelong income but vanishes at death, even if that is a week after retirement.

Lionel Martellini of EDHEC, a French business school, and Robert Merton of the Massachusetts Institute of Technology (a Nobel laureate in economics) have come up with an alternative. Workers would buy government-issued bonds while in employment; these would pay no interest until retirement. Over the next 20 years (the typical life expectancy on retirement) bondholders would receive payments comprising interest plus the return of the capital. These would be linked to inflation, or another measure such as average consumption. So a worker born in 1970, say, would buy a bond that made payments from 2035 until 2055. Every financial innovation needs an acronym, and these are called SeLFIES (Standard of Living Indexed, Forward-starting Income-only Securities).

They would act somewhat like annuities, though without protecting against the risk of living much longer than expected. One big advantage is that if holders die before the maturity date, the capital would be passed to their heirs. They could also be attractive to corporate pension funds and institutions such as sovereign-wealth funds. But if bond yields stay as low as they are now, workers will still need a big pension pot to be able to retire comfortably. The median pension pot of an American aged 40-55 is $14,500. That will not generate much income, whatever security it buys.